February 2018

Pan European real estate equities performed poorly in February with the benchmark (in GBP) falling -4.58%. This weakness was clearly not confined to property equities but the sector has now fallen -7.5% from its January 7th peak underperforming the wider equity market. Over the last month there was little differential in performance between the UK (-5.1% in GBP) and Continental Europe (-5.4% in EUR).

We are confident that the key driver of negative sentiment towards the sector remains generalist investors’ central concern that a rising yield enviroment is poor for a leveraged asset class such as property. We would counter that; as long as interest rates are rising in response to an improving economic backdrop then, subject to suitable constraints on the development of new supply, rents will rise as businesses and employment grows and wages rise. However in these conditions investors need to focus on earnings growth, further yield compression comes only in response to the prospect or the reality of rental growth.

The results season is in full swing and it is encouraging that virtually all companies who have reported this month exceeded consensus expectations particularly on earnings. However some sectors continue to experience negative investor sentiment even after they reported stable earnings. This was particularly the case with the retail sector in both the UK and Continental Europe. Hammerson and Intu, who are due to merge later in the year (subject to their respective shareholders voting in April) are the UK’s two largest pure retail property landlords and their respective share prices fell -9.3% and -10.3% in the month and are down -18.3% and -20.1% YTD. Europe’s largest shopping centre owners also fared poorly with Unibail -7.3%, Eurocommercial -11.9% and Mercialys, following solid results, down -7.8%. Negative sentiment has been further fuelled by more retailer failures including Toys R Us and Maplin but also rocked by CVA restructuring across the sector which will result in downsizing of space usage by operators from New Look to Byron Burger and Prezzo.

Pan European office markets, with the marked exception of London, continue to see rental growth and commensurate yield compression with good results from Fabege (Stockholm), Gecina, Icade and Fonciere des Regions (Paris) and Merlin (Madrid). Not surprisingly these names performed relatively well with Fabege +4.5%, Merlin +1.5% and Fonciere des Regions -2.8%.

German residential, the single largest sub-sector in our universe (c21% of the benchmark) has performed poorly since the beginning of the year. Again fundamentals remain as strong as ever with house price inflation aiding valuation coupled with wage inflation helping affordability as rents rise. However, there is a strong (and self-fulfilling) belief in the negative correlation of rising bond yields and falling share prices in this sub-sector and that has been the case with a c.10% deterioration YTD led by Vovonia (-9.3%) and LEG (-10.3%). The Berlin focused names, Deutsche Wohnen (-6.7%) and ADO Properties (+1.2%) have fared better as investors see value protection from greater rental growth regardless of the far higher valuation metrics.

The UK has the greatest political risk (even given the forthcoming Italian elections) and the economy continues to suffer from the uncertainty and therefore warrants an update on our positioning. In the UK the fund remains underweight retail (particularly prime), Central London offices (but not Greater London and South East offices) and UK majors whilst being overweight logistics, Segro (great results and down just -1.7%) and London Metric (-0.8%), student accommodation via Unite (-4.5% which was a buying opportunity given strong results) and a range of businesses with index-linked and long dated income. Supermarket Income Reit and Secure Income Reit were both flat on the month whilst PRS Reit, the UK’s largest private rental residential Reit successfully raised £250m, doubling its size just 9 months after IPO.

The Trust’s NAV fell -4.4% in February, modestly ahead of the benchmark (outperforming it by 19bps) whilst the share price fell in line (-4.1%).